Chapter 4 - Test your knowledge Flashcards
What are the primary uses of published accounts?
Published accounts provide information about the company’s activities and financial performance throughout the preceding year.
To some extent, they indicate the future prospects of the business.
Published accounts are a key element of communication with shareholders, the market and other interested parties such as bank lenders or suppliers.
The published accounts are used by investors and other parties to examine:
1.profitability: investors and shareholders will be interested in the
profitability ratios and financial numbers such as dividends and retained profits;
- sources or nature of profit: for example, whether the profit generated is from the sales of assets or normal trading;
- balance sheet strength: by looking at liquidity, insolvency and gearing positions; and
- trends: for example, looking for revenue and profit trends to identify strengths or any potential risks
What are the objectives of the strategic report?
The strategic report is a detailed report within the annual report and accounts,
written in non-financial language.
It provides clear and coherent information
about the company’s activities (such as what it does and why), performance,
position, the strategic position of the business and probable risks attached with
the business.
It ensures information is accessible by a broad range of users, not
just analysts and accountants who have sophisticated knowledge.
The purpose of the strategic report is to provide information to the members
of the company and help them assess how the directors have performed
their duties and functions.
What must a strategic report contain?
The strategic report must contain and provide the
following information:
- a fair review of the company’s business
- a description of the principal risks and uncertainties the company faces
- any change in the going concern assessment
- references to the annual accounts.
The strategic report of a quoted company must also include information on the company’s strategy, business model and disclosures about environmental,
employee and social issues (including human rights and gender diversity).
Briefly discuss the purpose of notes to the accounts in a published
annual report?
The notes to the accounts in an annual report provide information not
presented elsewhere in the report.
This includes:
- more detailed analysis of figures in the statements
- narrative information explaining figures in the statements
- additional information, such as contingent liabilities and commitments.
IAS 1 requires the notes to the accounts in the annual report to disclose the
following key information:
A. the basis for the preparation of the financial statements that includes specific accounting policies chosen and applied to significant transactions/
events;
B. information which is required by IFRS but not presented elsewhere in the
annual report; and
C. any additional information that is relevant to understanding which is not
shown elsewhere in the annual report
A plc sold a property to B plc on terms that the property will be leased back to A plc under a lease agreement and A plc continues to occupy the property. How will this transaction be recorded in the financial statements of A plc?
The substance over form concept will be applied.
The company must first
determine whether the transfer qualifies as a sale based on the requirements for satisfying a performance obligation in IFRS 15 ‘Revenue from Contracts with Customers’.
Under IFRS 15, the transfer of goods and services is based upon the
transfer of control – the ability to direct the use of and obtain substantially all of the remaining benefits from, the asset.
In view of this, the transaction will not be recorded as a sale transaction in the books of A; instead it will be treated as
a lease and accounted for as per IAS 17.
IAS 17 provides a single lessee accounting model, requiring lessees to recognise assets (representing its right to use the assets) and liabilities (representing its obligation to make lease payments). The asset will remain in the books of A and the money received from B by A will be recorded as a secured loan.
Outline the reasons why managers may engage in earnings
management or creative accounting
Creative accounting arises when managers use their knowledge of accounting
choices available to them to manipulate the figures reported in the accounts of a business.
They may resort to such practices due any of the following reasons:
- managers may be attempting to secure performance bonuses;
- to minimise tax liability;
- to increase share values, especially if the directors are shareholders;
- to disguise the fact that the business is close to insolvency; or
- to use as a bargaining tool in negotiations with suppliers, customers and
employees.
What are the key limitations of historical cost as a basis for the
measurement of assets?
Historical cost is the most widely used basis of measurement of assets.
Use of historical cost presents various problems for the users of published accounts as it fails to account for the change in price levels of assets over a period of time.
This not only reduces the relevance of accounting information by presenting assets at amounts that may be far less than their realisable value but also fails to account for the opportunity cost of using those assets.
The published accounts neither represent the value for which fixed assets can be sold nor the amount which will be required to replace these assets.
What is meant by recycling?
Recycling
Recycling is the term that the Conceptual Framework uses for the release of items in the OCI to the statement of profit or
loss in a subsequent period.
Income and expenses included in OCI should subsequently be ‘recycled’ (released) to the statement of profit or loss, provided that the recycling results in more relevant and faithfully representative information in the statement of profit or loss.
What are the two concepts of capital maintenance according to the conceptual framework?
The Conceptual Framework identifies two concepts of capital maintenance:
- financial capital maintenance
- physical capital maintenance
What is meant by financial capital maintenance?
The financial concept of capital maintenance can be further categorised as:
- money financial capital maintenance
- real financial capital maintenance
The only difference between these two categories is that money financial capital maintenance considers the time value of
money or the impact of inflation, whereas these are ignored in real financial capital maintenance.
A financial concept of capital is usually followed by an entity where the financial statements are referred to by its users in the context of purchasing power of the amount invested as capital or the maintenance of their invested capital.
what is meant by physical capital maintenance?
This concept works for an entity where the capital is regarded as its production capacity. Profit under this concept is earned only if the production capacity at the end of the year exceeds the production capacity of an entity at the beginning of the year, after excluding any distributions to or contributions from the owners.
This production capacity may be based on units of output. The main concern of users of these financial statements is with the maintenance of the operating capability of the entity.
This method is usually followed if the users of the financial
statements are mostly concerned with the operating capacity of the entity, as well as enhancing such operating capacity.
Most organisations use the financial concept of capital maintenance as it is easier to apply
